SEBI Guidelines for Issue of Rights Shares

Milind Wadkar Roll No. 11-759 VIT MMS Batch - 1

Rights Shares
Right shares are the shares which are offered by the company to the existing shareholders. Simply stated the existing shareholders have a right to subscribe for the shares which are offered by the company after initial allotment until some special right is reserved for any other person by special resolution in this respect. Section 81 i.e Further issue of capital of companies act 1956 deals with this and it states that where at any time after the expiry of two years from the formation of a company or at any time after the expiry of one year from the allotment of shares in that company made for the first time after its formation, whichever is earlier, it is proposed to increase the subscribed capital of the company by allotment of further shares. Rights Issue means an issue of capital under Sub-section (1) of Section 81 of the Companies Act, 1956, to be offered to the existing shareholders of the company through a Letter of Offer. The Guidelines shall be applicable to all public issues by listed and unlisted companies, all offers for sale and rights issues by listed companies whose equity share capital is listed, except in case of rights issues where the aggregate value of securities offered does not exceed Rs.50 lacs. (Provided that in case of the rights issue where the aggregate value of the securities offered is less than Rs.50 Lakhs, the company shall prepare the letter of offer in accordance with the disclosure requirements specified in these guidelines and file the same with the Board for its information and for being put on the SEBI website.)

SEBI Guidelines for Rights Issues

SEBI requires that firms seeking to issue equity via Initial Public Offerings or Further Public Offerings must meet certain profitability and/or capitalization thresholds. However, firms seeking to issue equity on a rights basis do not need to meet any such thresholds as per clause 2.4.1(iv) of the DIP guidelines. For instance, information provided on the SEBI website states: SEBI has laid down eligibility norms for entities accessing the primary market through public issues. There is no eligibility norm for a listed company making a rights issue as it is an offer made to the existing shareholders who are expected to know their company. There are no eligibility norms for a listed company making a preferential issue. In addition to having no eligibility criteria, SEBI has also recently removed certain disclosure requirements to make it easier and cheaper for firms to complete rights issues. Earlier, the disclosure requirements for rights issues were almost as exhaustive as for public issues. SEBI rationalized disclosure requirements based on the assumption that certain information about the entities [rights-issuing firms] that are listed and traded on the exchanges is available in the public domain for investors. Implicit in SEBIs basis for reducing disclosure requirements is the assumption that high quality disclosures are available to investors of listed companies, which may not be the case. SEBI has also introduced changes that make it possible for firms to utilize funds available from rights issues faster. For example, revised DIP guidelines now allow firms to utilize the proceeds from the rights issue as soon as the basis of allotment is finalized. One benefit of having no eligibility criteria is that there is no direct incentive for rights-issuing firms to manage earnings. For example, regulators in China have set specific thresholds for Return on Assets (ROA) that firms must satisfy to be eligible to issue equity on a rights basis, and researchers have found evidence of substantial earnings management surrounding rights issues (Chen and Yuan (2004), Liu and Lu (2007)). However, the lack of entry norms or reduction of disclosure requirements can also lead to potentially adverse consequences. SEBIs assumption that existing shareholders, and, in particular, minority shareholders would have adequate information based on the public disclosures of the firms issuing equity on a rights basis is likely not supported by studies of the quality of disclosures. These studies have found that while India receives high marks for investor protection and creditor rights, its record in practice is poor (Allen, Chakrabarti, De, Quain and Quain (2006)). Similarly, Chakrabarti, Megginson

and Yadav (2008) state that while financial disclosure norms in India are superior to those of most Asian countries, noncompliance with the disclosure norms is rampant. Other cross-country studies of investor protection also rank India low. For example, La Porta et al. (1998) find that among 18 countries following Common Law, India ranks lower than average on a set of criteria, including shareholder rights, creditor rights, rule of law and concentration of ownership. Therefore, the impact of the recent changes in SEBI DIP guidelines reducing disclosure requirements for rights-issuing firms remains to be seen.

Steps for issuing right shares

1st Step: Right shares must be in ratio of equity shares of existing shareholders. 2nd Step: Right Issue by 15 days notice Right shares will be issued with 15 days notice. This notice will be offer. Existing shareholders can either accept or reject this offer. 3rd Step: Right shares issue must not be opened more than 60 days under SEBI guidelines. Provision of 81 will not apply on private company. This rule will not also apply on conversion of debentures into shares. Benefits of Issuing Right Shares 1. More control on existing shareholders Because right shares are issued to existing shareholder, so there is no risk of losing of control of existing shareholders. Existing shareholders share will increase in company and they can take decision without any compromise with the principles of company. It is very helpful to achieve the missions of company. 2. No loss to existing shareholder By issuing shares to existing shareholders, value of share will increase due to stability in controlling power of company. So, there will not be any loss to existing shareholders with right shares. 3. No cost for issuing shares to public

Company has not to give any invitation to public, so advertising cost and other new issue cost will decrease with right shares. 4. Helpful to increase the goodwill of company It is also way to increase the goodwill and reputation of company in industry. 5. Capital formation Company can get capital at any time without any delay because company can easily issue of shares to existing shareholders just sending right shares offer notice. 6. More scientific Distribution technique of right shares issue is more scientific. Not all shares will get by single shareholders but it will be in the proportion of existing shares which is in the hand of old shareholders at this time. For Example A company is planning to raise funds by making rights issue of equity shares to finance its expansion. The existing equity share capital of the company is Rs. 50, 00,000. The market value of its share is Rs. 42. The company offers to its share the right to buy 2 shares at Rs. 11 each for every 5 share held. You are required to calculate: 1. Theoretical market price after right issue 2. The value of right 3. % increase in share capital Solution Market value of 5 shares already held by a shareholder @ Rs. 42 = 210 Add the price to be paid by him for acquiring 2 more shares@ Rs. 11 per share = 22

Total Rs. 232 1. Theoretical market price of one share = 232/7 = Rs. 33.14 2. Value of Right = Market price theoretical market price = 42- 33.14 = 33.86 3. % increase in share capital Present capital = 50, 00,000 Right issue Rs. 50, 00,000 X 2/5 = 20, 00,000 % increase in share capital = 20, 00,000 / 50, 00,000 X 100 = 40%

Underwriting of Right Shares

Sometime, company can contract with underwriter who promises that if existing shareholders will not buy, he will takeover all not right shares. Underwriters and sub-underwriters may be financial institutions, stock-brokers, major shareholders of the company or other related or unrelated parties.